The financial statements are reports that exhibit all the financial information of the company but are supposed to be prepared in a proper structure and format in accordance with IAS 1 (International Accounting Standards).
IAS 1 provides a detailed guideline about how to prepare a complete set of financial statements.
These statements are accompanied by footnotes or explanatory notes that explain the figures reported on the financial statements and portray the true and fair view of the statements.
There are four financial statements that should be prepared at the end of each year annually.
- Statement of comprehensive income
- Statement of financial position
- Statement of changes in equity
- Statement of cash flows
Footnotes to financial statements:
As explained above, the notes unravel the line items reported on the financial statements. As per accounting rules and principles, the financial statements should be neat and precise.
However, if you look at the perplexed and prolonged calculations behind the figures, it would take numerous pages to complete a single financial statement.
This would only create a mess and muddle up all the relevant information with jargons and computations making it inconvenient and onerous for the users to read.
Ergo, notes to financial statement are essential for reporting purposes. Without these footnotes it would be exasperating for the shareholders, investors and public to judge the financial stability of the company.
The notes make the financial statement trouble-free for the readers while maintaining its legibility.
What is included in notes to the financial statements?
We could say that there are two types of footnotes. As important as it is to explain the calculations and figures of depreciation, lease terms, stock options, hedging, long term debts, accrued liabilities, pension plans, income taxes, etc, the company is also obligated to report the accounting policies and methods it uses for valuation of inventory, revenue recognition, intangible assets, the nature of the business, start and end of the accounting period and others.
This implies that the two types of footnotes are texts and calculations. The calculations are disclosures to the line items reported on the financial statements that are impossible to be deciphered on their own.
For example, schedule of depreciation, schedule of lease payments, schedule of amortization is disclosed in the notes to financial statements and to explain the basis of these calculations we use texts to describe, in our example, class of the assets, the purpose of those assets, the acquisition of goodwill, the usage/purpose of the intangible asset, how the value of the intangible asset was assessed, interest rate for lease payments, start and end of lease payments, etc.
In the notes to financial statements, the company also has to report any subsequent events.
A subsequent event is an event that occurs after the accounting period has ended but before the financial statements have been issued for the same accounting period.
The GAAP requires you to disclose any subsequent events, the conditions of which existed before the year ended.
Another instance would be contingent liabilities. These are cash outflows of uncertain amount expected to happen at an uncertain time in the future.
Any contingent liability shall be disclosed in the notes to financial statements since they can’t be reported on the financial statements. An example would be warranty expense.
The notes also give all specifics of operating expenses. On the income statement we only report general admin expenses and selling and distribution expense.
However, the background of operating expenses as in all the other heads of expenses (example: fuel/utilities/depreciation) included are specified in the footnotes.